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The second covid wave is going to impact the recovery of many sectors, including real estate. The commercial real estate sector, especially grade A offices, has shown resilience over the past year with good occupancy and rent recovery levels. But the second wave may hit growth prospects as companies may go slow on expansion plans as work from home continues. This may impact the performance of real estate investment trusts (Reits), which invest the majority of their assets in rent-generating commercial real estate, at least in the short term. Michael Holland, CEO, Embassy Reit, spoke to Mint about the medium-term outlook of the sector and why investors should make Reits part of their portfolio. Embassy was the first Reit to be listed in India in April 2019. According to Value Research, it has delivered a price return of -2.8% CAGR since listing, as of 19 April. However, Holland said the return, including dividend and capital appreciation, is 24% since listing (absolute, not CAGR). Edited excerpts...

India has been hit by the second covid wave and it seems that work from home is going to stay longer. This is likely to impact the expansion plans of companies. How is this going to impact the commercial real estate sector and the growth prospects of Reits?

Prior to the onset of the second wave, we were witnessing an increase in occupier interest for new leasing. The increase in cases will slow down the return to office plans for many occupiers, but it doesn’t alter the fundamental fact that India is the go-to market for hiring digital talent and executing technology-supported services. The young Indian professional will continue to serve global businesses which, across the world, are more dependent on technology and less constrained by geography.

We have recently seen great results from technology companies in India, which have their strongest order books ever and have seen record hiring of new staff over the past quarter. We have witnessed some strong results from major banks in the US that rely on Indian technology to support their global business lines.

With the west’s growth outlook improving, we feel positive about the medium-term outlook for office demand once we get past this second wave, given the reliance of global businesses on workforces in India.

Is the restructuring exercise of Embassy Reit to simplify ownership complete? How is it going to benefit investors?

We have received approvals from the National Company Law Tribunal and the scheme came into effect in March. Dividends under the Indian Reit regulatory framework are tax-free in the hands of investors subject to a few conditions, one of which is that the trust owns the subsidiary special purpose vehicle in a single-tier structure. Historically, some of our holdings were held in a dual-tier structure, which we have now received permission to collapse and will have a single-tier 100% ownership structure. The simplification of the holding structure enables us to enhance the dividend portion of the overall distributions, increasing the overall post-tax distribution yields to our unitholders, given Reit dividends are fully tax-exempt for unitholders.

The minimum lot size for trading in Reits is 200 units. A higher lot size requires a higher investment amount. Do you think it needs to be brought down to increase retail participation?

After enabling three Reits to list in India over the last two years and creating a regime that has gained international and domestic acceptance, Indian regulators are considering synchronizing Reit trading lots with those of listed companies to make Reits more liquid and accessible to a wider audience through a 1:1 trading lot size. We would strongly support such a measure. The principle behind bringing down the trading lot size is to enhance liquidity and make the instrument more accessible for all investors to be able to transact at efficient market-clearing prices.

Lot size reduction enables broader retail investor participation, thereby enabling a segment of the population that can and should be able to invest in Reits safely and for all the benefits that the structure provides to unitholders.

It also enables potential entry into benchmark indices that allows passive tracking by index funds and diversifies the investor base. It also mitigates major movements that typically define trading patterns of thinly traded securities. Lack of liquidity affects the longer-term ability of Reits to efficiently utilize the capital markets to fund growth.

There have been two more successful listings after Embassy. How will the sector benefit with more players entering the space?

We welcome the addition of more Reits on the Indian exchanges. Reits are a $2 trillion asset class globally, and they were created specifically so that investors could invest in commercial real estate in fractional lot sizes and in a regulated and tax-efficient structure.

We believe that the Reit structure has permanently altered the face of the Indian office market. For India to have listed three Reits in two years speaks to how eager investors have been to embrace the evolution of the office market in India away from the fragmented, low-scale, variable quality market to a more institutionalized, concentrated, higher quality, compliant market that provides better product to occupiers and investors alike.

Why is it a good time to invest in Reits and who would you recommend should invest in Reits?

Reit is a mature and diverse asset class across the world. In the US alone, 87 million individuals invest in Reit stocks. Over the last 25 years, Reits have delivered a total return higher than S&P 500. Embassy Reit has delivered a projected total return of 24% since listing (in absolute terms and not CAGR) and has paid out quarter after quarter dividend totalling around 3,700 crore.

This demonstrates that Reit is a resilient business through the pandemic and has growth from multiple levers—contractual escalation, mark to market, on-campus development and acquisitions.

With this track record, an office Reit focused on catering to the Indian market should form a core component of any asset allocation strategy alongside equity and bonds for all retail investors.

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